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Netflix (NASDAQ: NFLX) missed their revenue expectation, while crushing their earnings per share number and suddenly the Wall Street Journal asks “Is Netflix the Next Crocs (NASDAQ: CROX)?“ Although the WSJ did not conclude that Netflix=Crocs, the suggestion alone is so absurd that I feel compelled to offer a response.
The Crocs Fad
For those who don’t remember, Crocs makes one kind of shoe–the “Crocs”–and is the owner of the “Croslite” patent on their own variety of lightweight rubber. While the company has tried to tinker with its line of products by offering colorful varieties and incorporating some twists to it’s sandal variety, by and large, Crocs is a one-hit wonder in the consumer marketplace. In 2006 the shoes started gaining in popularity and in 2007 the trend went viral. Everyone from toddlers to retirees sported the shoes on the beach, at the pool and even at the office.
In 2007, earnings peaked out at $168 million and as the trend went viral, the stock went parabolic. As the stock flew, the company took on more debt (albeit modestly so) in order to pursue an aggressive expansion of the Crocs retail presence and in an attempt to create another hit with consumers. In its peak year, Crocs boasted a market capitalization of $4.45 billion. Crocs’ 2008 revenues came in 15% below 2007 and the company lost another 11% of its revenues in 2009, while their operating expenses were on the rise.
Through it all, Crocs enjoyed three years of profitability and one year of solid earnings. The company’s shoes are still a popular product with some subsets of the consumer base; however, they were a trendy fad product which even the biggest enthusiast could only wear on a limited number of days each year. As can be expected, the product reached its maximum point of saturation and now is merely a niche offering amidst a host of alternative footwear.
Netflix Builds a Long Term Vision
Yesterday in my Netflix earnings recap, I highlighted the company’s steady margin expansion on account of increasing subscriber use of Netflix’ rapidly expanding streaming library. Netflix invested heavily in building out a capital intensive business, with a loyal and growing subscriber base. Unlike shoes, which people buy, wear and discard based on their fashion whims of the moment, Netflix subscribers demonstrate a high degree of loyalty and the company reciprocates by continually improving the quality and quantity of titles in their service.
Unlike Crocs, Netflix’ revenues from 2006 on have checked in at nearly $1 billion or more (in 2006, the company reported revenues of $996 million and in 2007, $1.21 billion). Never in Crocs history did the company bring in more than $1 billion in revenues in a year. And keep in mind we’re only talking about revenues here. Netflix profit margin has been expanding consistently through the years.
Rather than a fad, Netflix has spent time and money in building out an impressive utility-style service on which subscribers have come to rely. Moreover, the company has taken significant steps to ensure that it remains a step above any competition in transitioning from traditional media consumption devices towards the “cloud” and the Internet. While the stock only recently took off (I say recently relatively speaking here, as it’s really since the March 2009 bottom that it went ballistic), Netflix had been steadily building out a long term vision.
In the WSJ article they offer the following observation:
Netflix needs to keep adding to its subscriber base, both on the Internet and by mail order. One way to increase sales is to deliver its streaming videos through television, not just over the Internet. Buying a company like TiVo could provide Netflix with the set box technology to get into people TV’s. But TiVo has been rapidly shedding business.
This shows a clear lack of understanding as to how people use Netflix and how the company makes money. One doesn’t have to venture far to learn that Netflix is available for streaming on TV through the Playstation 3, Xbox, the Wii and the Roku streamer, among other devices. Netflix very much enjoys a solid TV presence ALREADY! Additionally, subscribers can now access the entire streaming library on the go using the Netflix iPad app. Streaming isn’t about “increasing sales”, it’s about offering subscribers the latest and best way to access the growing library of watchable content.
The WSJ correctly points out that there are significant barriers to entry in Netflix market, whereas Crocs enjoys no such advantage.
Netflix has the license to 24,000 streaming videos and 100,000 DVD titles that it sends through the mail….While Coinstar’s Redbox kiosks offer $1 rental offerings (Netflix offers monthly subscriptions as low as $5), Bloomberg notes that Coinstar is trying to “close the gap” in its offering of 200 titles, compared with Netflix’s 100,000. That is quite a gap.
The fact that Netflix steadily built and invested into growing its businesses has afforded the company a comfortable moat against competition. A head start in innovation makes it difficult for even better capitalized rivals to capture Netflix market, hence the ongoing rumors that Amazon may be an interested acquirer.
Far from the Next Crocs
It’s one thing to claim that Netflix stock is overvalued, another to posit the question whether “Netflix is the next Crocs.” Not too long ago, Felix Salmon argued that Netflix stock was overvalued because the company is essentially a utility provider–a database of movies in exchange for a fixed monthly cost, not too different than how people subscribe to cable. While I disagree and see avenues for significant growth, there is far more merit in asserting equity overvaluation, than in analogizing Netflix to a hollow one-hit wonder company which made little sense being a publicly traded stock to begin with. As is always the case with a retail product, Crocs was always at risk of the incredibly fickle consumers tastes, which these days change on a daily, or even hourly basis.
The WSJ article seems to suggest that the hit taken by Netflix’ shares following their earnings report may instill a sense of panic in the company to do something quickly in order to increase its revenue growth rate. That suggestion is missing the point. Netflix is where it is largely because they have not concerned themselves with the volatile and fickle analysis of quarterly earnings reports. It’s not often that you see shareholders flee a company with rapidly accelerating earnings growth and improving profit margins, and only natural for a stock up over 125% above its price a year ago today to experience a short-term pullback. Even Apple (NASDAQ: AAPL) pulled in on its way to world domination.
Disclosure: No relevant position.
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That article seems like it was written to grab reader's interest with a shocking headline and provide superficial analysis to back it up. How is streaming video content a fad similar to rubber sandals?
If customers are so loyal, why is the churn going up? The margins were bumped a little this Q, but more important, guidance given by NFLX implies subscriber growth of over 1 Million subs, but no increase in profit, a clear destruction of margins going forward. NFLX is not CROX, it's true- CROX has actually recovered quite a bit since it's meltdown, whereas once NFLX melts down it will more closely resemble Blockbuster or Virgin Megastores.
Sounds like someone is short NFLX. Please let's talk facts here. Netflix churn this past quarter was DOWN from a year ago (4% vs. 4.5%). Subscribers are getting MORE loyal. Moreover, subscriber growth was exceptionally strong, coming in above estimates. Revenue per subscriber didn't grow as much as anticipated, but that's because subscribers are rapidly increasing their using of the higher margin streaming services offered by NFLX. Destruction of margins? Look at the trends and it's clear that NFLX is moving into higher margin territory. The future of their growth is in streaming and that future is playing out now.
Haha yep I just don't see it. Especially considering the depth of NFLX library and the amount of capital was spent in building up their service. Competing will not be easy! Sure there are plenty of other media options, but NFLX is so cheap and fits a perfect niche for people's demands.
Good job exposing the ignorance of the WSJ. Can't believe that they don't know that streaming internet can be shown on a tv. This is just a perfect example of why you guys are so great and the WSJ is pure old school.
Churn is a metric that should be compared sequentially, and it was up to 4.0% from 3.8% last Q.
SAC (sub acq cost) rose substantially, meaning they are paying more for lower quality subs.
Loyalty? they had 2.025M cancellations this Q, up from 1.670M a year ago. In fact, they churned off 2 times as many subs as they added this Q.
Yes I am short, and happy to be short. You make some good points, but I think you need to address the terrible guidance – that is what the Street reacted to- not the subs added this Q. Why will they add a million subs and make no added profit? That's what the Street hated.
The long-hanging fruit of easy sub adds from the video game consoles is done.
My favorite quote from the earnings call was the CEO's non-answer to a question about the low quality of the streaming content: “the power of NFLX is to take a lot of content that may not be the hottest content and make it feel like it's an incredible service to subscribers”
The last time I heard answers like that, it was MSFT in 2000, when AAPL was ramping up the iPod. I expect similar stock performance.
Churn should be monitored on multiple time frames. The longer-term trend for NFLX is for more subscribers to stick with the service. Net subscriber increase was north of 1 million. Sure that was slightly slower than the first quarter, but I'm not seeing where you get the churn being 2x as many subs as they added this quarter.
I'm not saying I would step in and buy today, but in time, I can't wait to get long this company for the next leg higher ($90 is where I'm looking for a feeler, but I wouldn't be surprised if I don't get my way).
You are correct, as the guidance was certainly a little lighter than hoped. That is surely the primary culprit for the extent of the post-earnings drop. One thing that the company is doing right now is investing heavily in increasing its delivery infrastructure, in addition to investing heavily in growing their library. This costs money in the short-run, but will be very catalytic in the long run.
I use Netflix to stream through my Playstation on a regular basis, and not only would I say that the quality is very strong (not Blueray strong, but DVD strong), it's also continuously improving.
In 2000, Microsoft was one of the world's biggest companies with already stalling growth. Considering the scope of the media market, NFLX is both a baby–it is both you and small. It's much harder to grow a massive enterprise than it is a young, small and nimble company in a dynamic field.
Thanks for your comment, I enjoy the discussion!
Agreed- i'm glad to discuss NFLX with someone that actually knows what they're talking about. When streaming quality was discussed, it wasn't about picture quality, it was about the poor quality of shows and movies. The CEO was asked what % of the top 500 DVD titles were also available on Watch Instantly and he wouldn't answer because the number would be so embarrassing.
The churn I refer to is the fact that NFLX had 2,025,000 subs cancel in the Q and 3,059,000 gross adds, which is how they get their 1,034,000 net adds number. This is not what people would describe as loyalty. Churn rates at the highly hated AT&T were about 1.1%. Their may be a core group that is loyal, but the vast majority of people don't stay with NFLX, or at best, they come and go during the year. Approximately 7.8M people left NFLX last year, and they only have a base of 15M subs now – that is some terrific churn!
Not sure where I stand on nflx. I think I am going to let the dust settle on this one. It got ahead of itself, but I don't think the growth story is over on this. It is certainly no BBI. I am pretty sure NFLX put the nail in the coffin for Virgin and Blockbuster.
Ah yes that's definitely true. The streaming library for Netflix is not quite there yet in terms of new releases. That being said, the depth of the library is very impressive and improving rapidly.
I hear ya with regard to the churn. That is higher than your standard utility provider, but the net growth in subscribers continues to impress. I think with Netflix, while it's still in the growth phase and considering it faces more competition than the likes of an AT&T (in terms of variety of media consumption options), it will naturally have a higher churn rate.
What impresses me most in a lot of ways is the anecdotal uptake of NFLX. Just from hearing my parents' generation talk about how awesome NFLX is, and to see their adoption of even the streaming service, is demonstrative of how far NFLX has come and how much more room it has left to grow.
Like I said before though, I do think there could be some downside for the stock in the near-term, and will use that downside to look for a good longer term entry. The real growth will come when as you pointed out, the quantity and quality of the streaming library takes the next steps. The wheels are already in motion for that. Just in the past 2 weeks they've signed deals with studios, including an expanded streaming license from Warner Brothers.